The Conservative party is committed to holding a referendum on the UK’s membership of the European Union (EU) in 2017 – and many voters seem keen on having the opportunity to express their opinion. So what would be the consequences of a majority vote in favour of leaving? ‘Brexit’ is likely to have a significant negative impact on the UK economy, writes Joao Paulo Pessoa.

Eurosceptics emphasise greater national sovereignty from Brexit while Europhiles tend to focus on the importance of ever greater unity to reduce the risks of the political conflicts that ravaged Europe in the first half of the twentieth century. These are important matters, but we focus on the more mundane (but quantifiable) economic issues.

Leaving the EU would bring home the equivalent of about half a percentage point of national income, since the UK would transfer fewer resources to subsidise poorer EU members. This would be the main economic benefit of Brexit.

The most important cost would be in the form of lower trade. There are three possible reasons why trade costs may increase after leaving the EU:

Higher tariff barriers between the UK and the EU.

Higher non-tariff barriers to trade (arising from different regulations, border controls, etc.) between the UK and the EU. These barriers are particularly important in services where the UK is relatively strong.

The UK will not participate in future steps that the EU takes towards deeper integration reducing non-tariff barriers.

Our analysis uses a state-of-the-art quantitative model of international trade to estimate the effects of Brexit on trade and quantify the consequences for national income.

Our initial ‘static’ calculations suggest that even in the most optimistic scenario, there would be an overall loss of national income of 1.13% driven simply by current and future changes in non-tariff barriers. In a pessimistic scenario, the overall loss swells to 3.09%, with most of the impact coming from higher non-tariff barriers (2.55%). These far outweigh the fiscal saving. In cash terms, the loss is £50 billion in the pessimistic scenario and still a substantial £18 billion in the optimistic one.

But these numbers do not take account of several other ‘dynamic’ forces, for example, the effects of trade on growth. Trade could increase productivity via more competition, innovation and adoption of technologies.

Using a different approach that factors in more realistic dynamic losses from lower productivity growth, a conservative estimate would double losses to 2.2% of GDP even in the most optimistic case. In the pessimistic case, there would be income falls between 6.3% and 9.5% of GDP. To put these numbers in perspective, during the 2008/09 global financial crisis, the UK’s GDP fell by around 7%.

There are several other potential economic effects of Brexit. These include the effects of regulation, immigration and foreign direct investment (FDI).

The UK received the most FDI of any European country in 2011, and was second only to the United States in terms of the stock of inward FDI around the world. Part of the attraction of the UK is as an export platform to the rest of the EU, so if the UK is outside the trading bloc, this position is likely to be threatened. This matters because foreign multinationals tend to be high productivity firms and they bring new technologies and management skills with them.

Outside the EU, the UK could restrict immigration from the rest of the EU and vice versa. In economic terms, migratory flows act much like trade as people tend to move to where they can be more productive and earn higher incomes, increasing total welfare. Other studies find that restricting this mobility will, just like restricting trade, reduce UK overall welfare. Moreover, other evidence suggests that there have been no negative effects on jobs and wages of native Britons from the waves of EU immigration. So even on distributional grounds, immigration does not seem to have been damaging.

Currently the UK is able to influence the rules and regulations governing the EU single market. Even if the UK maintained full access to the single market, it would be in the same situation as Switzerland: UK exports would have to follow these regulations without being party to agreeing them.

In sum, our current assessment is that leaving the EU would be likely to impose substantial costs on the UK economy and would be a very risky gamble. The dream of splendid isolation may turn out to be a very costly one indeed.

For more details see: ‘Brexit or Fixit? The Trade and Welfare Effects of Leaving the European Union’ by Gianmarco Ottaviano, Joao Paulo Pessoa, Thomas Sampson and John Van Reenen

Joao Paulo Pessoa works at Centre for Economic Performance, part of the London School of Economics

there will be no higher tariff barriers – that is a lie. If you don’t want to buy our goods, you can buy cars elsewhere for much more than you pay us. YOU RELY ON US TO BUY YOUR GOODS MUCH MORE THAN WE RELY ON YOU TO BUY OUR GOODS. We can get a much better price by developing export markets in China, India.
As for no-trade barriers, whether you negotiate with us or you suffer. we don’t care, we can form friendships with many other thriving countries while the EU declines. The whole point of our leaving the EU is to NOT participate in deeper integration. Your model is based on the assumption that our negotiations for trade depend on political membership of the EU, but that is not and never has been true, it is another stupid lie. We will negotiate the terms of our trade relationship with Europe as we always have done, as an independent sovereign and fully democratic modern state. Being able to control the quality and quantity of migrants will enable us to operate our industry with much better efficiency than at present, because inward migration is posing huge problems. WE DON’T NEED THE EU AND WE INTEND TO QUIT. Stop kidding yourselves, no one believes your lies any longer.

Comment by Jack Rainbow on September 13, 2014 at 8:49 am

@Jack Rainbow: the only problem with Mr Pessoa’s writing is that it doesn’t go far enough. The fact of the matter is that in 2017 the Tories intend to ask us to vote on something the costs of which will be unknown. You Eurosceptics love to tell us all how much EU membership costs. What you never tell us is how much it will cost to leave. The whole basis of the Brexit case is that the UK will be given the same deal as the EU has cut Norway (and Switzerland). What on earth makes you think that France and Germany will want to give the UK – their biggest competitor – the same deal that they’ve cut for a nation with a population of less than 5m people? Let’s get this straight: THERE IS NO PRECEDENT FOR A NATION LEAVING THE EU. And the chances are that the EU would wish to discourage other nations from leaving, so will want to play hardball in any negotiations.

But you could be right. It could all be fine and they’d trade with us on the same terms. Who knows. I don’t – and nor do you. But you want me to vote to leave without knowing the cost. To recap, here is the Cameron process. 1. He renegotiates the UK’s terms of membership. 2. Following those negotiations, he holds an in/out referendum. 3. If we vote to leave, we leave. At no stage in that process is there any mention of negotiating the terms of the Brexit before the vote. Would it not be more honest, Sir, if Mr Cameron were to take it upon himself to negotiate the terms of leaving the EU before the referendum so they can be analysed by comentators, politicians, and above all, businessmen who create wealth for this country by trading their goods and services abroad?

This issue is constantly being swept under the carpet by the Tories and their UKIP masters.